Investing in the age of climate transitions: The case for universal disclosure of Paris alignment by investment funds
28 April 2021 – Understanding the climate performance of investment funds should be made simple to all investors. Lucy Auden, Senior Programme Manager for the Investment Leaders Group (ILG), analyses the current approaches to measuring fund climate performance and makes the case for a universal disclosure of Paris alignment. This analysis will be followed by a report in summer 2021 which proposes a disclosure methodology and explores the underpinning science, methods of emissions projection, and distribution of carbon budgets used by current approaches.
While the pandemic has shrunken global economic activity, it has also highlighted the need for a green recovery, and momentum has slowly grown - evident from the increase in the demand for sustainable funds despite the market turmoil. Interestingly, the pandemic also brought changes to consumer lifestyle and purchasing decisions, favouring sustainable choices. With the US making an official return to the Paris climate accord and the resumption of COP26 in November 2021, the climate crisis will again be at the centre of conversations around the world and it is no surprise that investors are increasingly interested in the impact of their investments on global temperature rise. The trend towards incorporating climate evaluation in investment decisions will only rise, driven largely by a younger generation of investors who want their money invested with climate in mind. Alongside investor's desire to align their portfolios with their values, it is also in the best interests of the investment management industry to build resilience to climate risks and stop further temperature rise. Research conducted by Cornerstone Capital Group found that $3-24 trillion or 2-17% of global financial assets are exposed to financial risk and loss stemming from climate change.
What does good look like?
Investors need to know: “Are my holdings helping or harming the stability of the climate?” They also need the answer communicated in way that is comparable and easily understood, and supported by a scientifically robust and transparent methodology. It turns out that this simple question is answered in a variety of ways. The latest report by ILG shows how current attempts to disclose the climate performance of funds vary across asset managers, from carbon intensity, emissions avoided, and assessment of assets' exposure to climate risks. While each method has its uses, the diversity makes comparison difficult and not all measurements give investors a clear picture of their impact on the climate. For example, whilst benchmarking emissions reporting might show Fund A has a lower carbon intensity than Fund B, that does not necessarily mean that Fund A is in line with the Paris ambition. It may well be that both funds have poor climate performance in absolute terms, but investors are not easily able to make that judgment with the tools at hand.
Why a temperature score should be included as a basic reporting requirement for all funds.
Reporting a fund’s impact on climate stability should be standardised, and an explicit measure of alignment with the Paris ambition included in the list of measures reported by investment managers: a temperature score. Why this metric? A temperature score gives investors a snapshot of their investment's impact on climate stability. It offers a meaningful, outcome-based measure in degrees centigrade (°C) that reveals instantly how a portfolio aligns with the Paris ambition – keeping global mean temperature rise well below 2°C between now and 2050.
This ILG’s analysis paves the way for a second report, published this summer, which will propose a temperature score methodology that converts a company's emission intensity figures into a score expressed in degree Celsius (°C).
The base layer of the methodology will use a straightforward method that uses a company's current emission intensity (tCO2e per US$ 1million revenue) to determine its temperature ‘score’, without the need for external modelling scenarios or assumptions about the company’s behaviour in the future. The goal of this methodology is to provide financial institutions with the tools to evaluate the climate performance of their assets without depending on complex modelling scenarios. This simple, potentially standard approach aims at supporting the uptake of temperature scoring across the industry, and it is offered as an open standard for use by the investment industry.
Temperature scores are not only used as a reporting metric – they are also used in asset analysis and portfolio management. Different alternatives are therefore required to address those needs. The methodology will also offer different levels of complexity, facilitating the evaluation of portfolio alignment to Paris based on sectorial and regional decarbonisation approaches. Building on the base layer, it will offer a sectorial alternative that takes sectorial decarbonisation pathways into account – useful for analysing the climate performance of assets in sectors such as power and transport, which are expected to decarbonise faster than other sectors.
The final layer of the methodology will offer a regional alternative that uses regionally differentiated decarbonisation pathways – essential to analysing the equitable distribution of carbon budget allocation across developed and developing countries. Both sectorial and regional approaches make use of complex modelling scenarios of the global economy.
As well as proposing a layered methodology, the report will explore current temperature scoring approaches. In doing so it will aim to foster familiarity within the industry and aid investors to choose the most appropriate scoring methodology.